Labour has dumped its self damaging policies on GST exemptions. They should kill off one or two others before the election spotlight exposes them as similarly dumb. Prime candidate is the "NZ Power" nationalisation of generation, the most competitive, most risky, most capital intensive part of our industry. Adding political risk to the already daunting risks of investment decisions in generation where we have a world standard regime is nuttiness of the kind that resounds for decades.

Ask Max Bradford, and his was merely an early implementation of the regulatory separation that is now orthodox and respected around the world. In electricity, the economic consequences of wrong judgments last for decades, but the political consequences of unpopular changes last for the perpetrator's lifetime, and that is just when they are orthodox.

The best advice to a politician awaiting evisceration over a mistake is to spill all yourself. David Parker could earn respect in the long term if he said now that his brain-child was premature, and that after all the feed-back what he should have promoted was a resource rental charge on water through the turbines. The absence of such a charge is the only argument that even partially rescues his scheme. To avoid distorting generation too far against hydro he could introduce it at the same time as Labour make the carbon charge bite, which they may be obliged to do by the Greens..

If he withdrew NZ Power shortly he could easily endure the mockery from National. The credit would outweigh it, as long as it did not appear to have been forced on him by David Cunliffe. At this stage of the cycle the mockery would be harmless by election time.

As a balancing position he could also undertake to over-ride any Commerce Commission failure to undertake an early review of the electricity distribution price control Input Methodologies on return on capital. That would ensure that at least part of any increase in the cost of electricity from a water price would be offset in the charge to consumers, by reducing the excess returns where there is a market structure (monopoly) problem.

For those who have not understood my earlier posts here and here on the High Court’s decision on Wellington International Airport Ltd & Ors v Commerce Commission, the 13 December edition of Energy News explains the issues. With their consent, here it is in full:

The Commerce Commission has been put on notice to reconsider how it uses the range of capital costs it calculates for the electricity sector.

The High Court has endorsed the input methodologies the commission uses in regulating electricity and gas distributors. But in a ruling issued late Wednesday, it says alternative proposals put up by the Major Electricity Users’ Group raised “significant doubt” about the commission’s decision to apply a weighted average cost of capital based on the 75th percentile of the industry range the regulator calculated.

MEUG had argued that the commission’s choice of the 75th percentile instead of the mid-point of the range showed an inappropriate bias in favour of suppliers and was unnecessarily generous. It calculated the difference between the two post-tax WACC estimates – 6.49 per cent and 7.22 per cent – would cost electricity consumers close to $129 million a year.

MEUG argued for a mid-point WACC, or for the commission to adopt a two-tier system with the higher return from the 75th percentile only available on new investments.

The court observed that it was probably understandable that the commission, establishing a new regulatory regime, would not want to risk deterring investment by providing too low a rate of return.

But the court – comprising Justice Denis Clifford and lay members Robin Davey and Rodney Shogren – doubted applying the higher WACC to a firm’s regulated asset base was necessary to promote investment and innovation.

Not rational

“The idea that greater revenues produced by higher allowed earnings on past investments (ie on the initial RAB) provide the wherewithal for more future investment is contrary to rational investment choice," the court said in its 661-page decision.

“Those existing higher earnings, once earned, are a given. The source of funds for future investments does not influence the riskiness of future investments; nor, therefore, does it influence their attractiveness. If anything, an abundance of capital is likely to lead to wasteful investment.”

But without more positive supporting evidence from MEUG, the court said it was not able to be sure that a mid-point WACC would have produced a `materially better’ input methodology – the standard to be met in a merits review appeal.

For the same reason it had no means of implementing the group’s `two-tier’ WACC suggestion and the commission’s doubts about it could not be addressed. Accordingly, the court left the commission’s 75th percentile choice unchanged.

“We are mindful that the IMs will be reviewed. At that time, we would expect that our scepticism about using a WACC substantially higher than the mid-point, as expressed above, will be considered by the commission.

“We would expect that consideration to include analysis – if practicable – of the type proposed by MEUG. We would also expect the commission to consider MEUG’s two-tier proposal in light of our observations. We acknowledge that further analysis and experience may support the commission’s original position. But they may not.”

Win for consumers

MEUG executive director Ralph Matthes says the decision is a win for the group and potentially for consumers. Next time the input methodologies are up for review, a move back to the 50th percentile will definitely be “on the table.”

But given the large sums involved – a reduction of about 4 per cent, or $20 million a year, in the gross revenue from Vector’s electricity business alone – the group will try to get early action from the commission, Matthes says.

Whether that could be achieved before the start of the next regulatory period starting in April 2015 is unclear, but the group will certainly investigate that.

“I think there’s an urgency to actually undertake that review,” he says. “We’re talking about some pretty big sums.”

MEUG was among nine parties that went to court in September last year to challenge the input methodologies the commission settled on in December 2010 to police the returns of electricity and gas distributors and some services provided by the Auckland Wellington and Christchurch airports.

Other appellants included Powerco, Transpower, Wellington Electricity Lines, Air New Zealand and the airports.

Leverage

The WACC range was one of four appeals MEUG lodged. Matthes says it was defeated on two minor claims relating to how debt issuance costs and asset betas should be applied in the cost of capital calculation.

But he says the court also gave some support on its argument around the commission’s treatment of leverage in the WACC calculation.

In setting the mid-point WACC at 6.49 per cent, the commission assumed a notional leverage of 44 per cent for Transpower and the electricity and gas distributors.

MEUG had argued the model the commission used should have either assumed no leverage, or should have had debt beta added to provide a more reasonable figure.

The court did not accept MEUG’s “novel” proposal, but nor was it satisfied that the commission had really addressed an anomaly in the capital asset pricing model it used in which WACC increased with leverage, when it should have fallen.

Matthes says the issues are complicated and MEUG’s proposal is at the leading edge of finance theory and regulatory practice. The group has gathered more information since 2010 and will keep working away at the issue.

“We’re not going to give up on bringing that one back into play.”

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Comments

paul scott

January 27th, 2014

8:11 pm

Yes, some esoteric stuff in this article.
But at the consumer level :
It costs us $200 to $300 per month for electricity in Christchurch.
Mostly clients are in the home in Winter and we back them up with wood for the fire.

I compare this with about $40 or $50 in Bangkok. for the electricity for [ mainly ] air conditioner in a small space.
If I equated the areas to heat or cool the costs would be not be too dissimilar..

Then lets consider Internet and telephone.
NZ payments to the idiot Vodafone are $150 a month in Christchurch.
In Bangkok my Internet quite fast costs me $12 a month.
That we pay 12 times in NZ that price for Internet /land phone similar in Bangkok.